Small Business Owners: Save on Taxes By Prepaying with your Credit Card
Did you know that prepaying your business expenses on your credit card could save you money when tax time rolls around? When you make a business-related charge on your credit card, you can recognize the expense as of its transaction date, even if you don’t actually pay it off until the next year. Using this technique allows you to defer your income.
There are a number of caveats, however.
1. Are you using cash-basis accounting?
The first precondition is that your business must be using the cash-basis method of accounting (as opposed to accrual), where income is not counted until revenue is actually received and expenses are not counted until they are actually paid.
2. Will you be in the same or lower tax bracket next year?
Then you need to consider whether it’s in your best interests to defer your income at all. If you expect that you will be in the same or lower tax bracket next year, you will probably want to defer as much of your income as possible to the future, so prepaying will make sense. If instead you anticipate that you will be in a higher tax bracket next year, you’ll want to realize as much of your income immediately while deferring your expenses. In this case, you would not want to prepay your expenses.
3. Does the economic benefit of prepayment last less than 12 months?
Assuming you meet the other conditions, you can prepay your expenses with a credit card and recognize the expense immediately. This favorable treatment does not apply to revolving store cards, however, which means that you can’t deduct your business expenses on your Sears account until the bill is actually paid.
In general, you can prepay up to a year’s worth of expenses and still recognize them immediately. According to this CPA firm, the prepayment should meet the following conditions:
- The expenditure is an actual payment — not a refundable deposit,
- The prepayment is for a substantial business purpose and not merely to avoid taxes, and
- The deduction does not materially distort income
With a few days left in the calendar year, it’s still not too late to take advantage of this technique. This is one instance where charging now could end up saving you money later.